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You can contact the author (Teguh Hidayat) by email, teguh.idx@gmail.com. The author live in Jakarta, Indonesia.

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What is Tapering? Is it Good or Bad?

This December may be the 'anxious months' for investors and
traders, as
there are several issues that feared would cause further decline of Jakarta Composite Index, whereas its position was already low. One such
issue is the problem of tapering, and that is what we will discuss in this article.

Before we get
into the discussion about tapering,first I
want to comment on the hike of BI Rate, which has reached 7.50% (and could rise again). The hike, as you know,
aiming to reduce the amount of money (Rupiah) in circulation, where it is expected to be able to suppress the
rate of inflation, as well as strengthen the value of Rupiah, which at this point had already been through the level of
Rp12,000 's per US dollar. So if we
take this point of view, the BI rate hike is actually
good for the economy.

But on the other
hand the BI rate hike could also slow down the economic growth, because it could cause banks to tighten their lending, including to the property sector (mortgage loans). A rise in interest rates
due to the increase in the BI rate could also cause the banking business become
more vulnerable to the risk of bad debts, which ultimately led to losses for the bank. But
so far there the
performance of the banking sector in the long term is still good, no matter if the rate goes up or
down.

That's why, when
the BI rate either raised, unchanged, or lowered, you can not directly interprete whether it would be good or bad for the economy. BI Rate
hikes could mean good if the goal is reached while the 'side effects' was not too significant.
On the other hand, the BI rate hikes could also mean bad if it fails to achieve
its goals, while the side effects are more dominant.

But if we assume
that the guys
in Bank Indonesia (BI) must be very
aware about the direction of monetary policy, then the current position
of BI rate is must be the best for the current national economy, or at least according to Agus Marto et al. The
point is, wheter the BI Rate is at 5%, 6%, 7%, or whatever, then it is the most appropriate to the economic situation in
Indonesia. I mean, sure youwould agree that Agus
Marto is not the type of big mouth lawyer like Farhat Abbas, or rude politician like Ruhut Sitompul, but he does understand the
economics.

Okay, then how
does it with
Tapering?

The term
'tapering' is actually a term in the world of sports, that is a situation where
the athlete take a rest on one day before the game. For example, if Mike Tyson will have a boxing match
on June 5, then of course he will train in much
advance, can be many months before the match. But just one day
before the game, on June 4, he will rest completely, perhaps by simply watching
TV at home all day. This break condition is called tapering.

While in the world of economy, especially
monetary, tapering is the reduction in bond purchases by the Federal Reserve
(the Fed, the U.S. central bank). So initially, in order to encourage economic
growth, the Fed printing money in a certain amount and then distributed it to the community, by
buying bonds issued by companies. This policy known as quantitative
easing (QE). With the increase of money in economic circulation, it is expected that the level
of consumption, investment etc. will also be increased, which in turn would grow the economy.

The amount of
new printed money
is U.S. $ 80 or 85 billion per month. Of course, the Fed can not continue to funnel the money into the market,
because it can lead to inflation and weaken the currency of U.S. Dollar itself.

So after
reaching a certain limit, the distribution of the new money should be reduced, and this is what is
meant by tapering. Why it is called tapering? Because the goal is to 'rest' the economy after being driven to 'train' continuously. Training for what? To be
able to grow. When an American company/people receive money from the Fed, then it does not mean that the economy
could automatically direct to grow, but the people would have to spend the money on
consumption, investment, etc., then the
economy will (expected to) grow. The efforts to spend the money for good cause, like for example an employer who immediately build a factory after
obtaining a bank loan, which could be analogous to 'train' for the purpose to
improve the economic conditions of their own, and ultimately grow the national economy as a
whole.

But of course,
just like a real sport athlete, the people should also take a break from their activities of spending the new money after a certain time, and
that's why tapering is required. Because if the Fed continuously funnel new
money into the community while the community itself was 'tired', then the money is not going
to help the economy, but will only cause inflation.

So a little
different from the BI rate hike where the objective is to reduce the amount of
money (Rupiah) in circulation, the tapering is aim to reduce the rise of the amount of money (US Dollar) in circulation
(the Fed still adding new printed money to
the community, only the amount of the addition is reduced).
But market concerns remain the same: If the money supply is reduced, then it
means that there
is no more money
to be spent,
and it could hamper the economy. As a result when last month the BI rate was raised, JCI had fell. Similarly,
if later the tapering
is actually effective, the Dow Jones could fall as well. And if the Dowfallen, usually
JCI will be dragged down.

But would the decrease occur
for a long period of time or just temporary? Well, that's what we do not know.
If we use the
example of JCI, the BI Rate position at this moment (4,200’s) is much different compared to its initial position before
starting to be raised, ie 5.75% (now it is 7.50%), and consequently the JCI has gone far down from its
peak position, ie 5,200’s. Although one thing to be noted here is that JCI reached its peak in April only because driven by
the euphoria over the influx of foreign funds, rather than fundamental factors.

As for Dow
Jones, since tapering itself is still not yet in force, then the index is still
rising. But since the issue of 'United States Shutdown' has dissapeared some time
ago, there are manyanalysts who remind the
investors about 'the dangers' of this tapering. Well,
if we read again the above, the fact
is that tapering, when it is effective, will have a positive impact. Should the Fed finally enact tapering,
then it means that America has reached the economic condition where the tapering is required. If until now
the Fed has not imposed tapering, then it means that it is still not needed yet. As simple as that,
and nothing is to worry about.

However, this
does not mean that the Dow Jones will not be corrected at any time later,
either when it the tapering is finally effective, or delayed further. If you check the valuation of stocks that of Dow components, many of
which have been recorded PER more
than 20 times, or already relatively overvalue. For comparison, the average
PER in the current JCI position, for ten stocks with the largest market capitalization outside UNVR and HMSP (because the two are extremely high in its PER), is less than 11 times.

That's why if viewed from the side of valuation, the Dow
is prone to be dropped, though of course we do not know when it will happen. But my point is, the tapering
is not a real problem at all, but just another magazine-cover-story after the Euro Crisis, Greek Crisis, Debt Ceiling, Fiscal Cliff,
and the United States Shutdown. Trust me, after the ‘story’ disappears by itself there would
be anotherstory, and other stories, and so on until.. forever.. as long as stock market
exists. If
you are includethose who are still easily worried by stories like
this, just
calm down, you'll also be familiar anyway :)

However, through this blog I will strive to continue
to deliver an update on the latest issues related to national and global
economy, so just stay tuned!